Shadow Open Market Committee (SOMC) Event

>> Michael Bordo: Hello everybody. Hi, I'm Michael Bordo and I would like to welcome all of you to our conference. A conference it's called a 50 year retrospective on the Shadow Open Market Committee and Monetary Policy. And I'm gonna talk a little bit about the Shadow and then introduce John.

So the Shadow of a Market Committee was founded in 1973 by Alan Meltzer, Carnegie-Mellon University. Carl Bruner, who was at Rochester, and Anna Schwartz of the NBR, and Anna, I worked with her for 40 years. So Anna was just a really special person, but the other two were two.

And so what they did was they wanted to provide a constructive forum for improving monetary policymaking. And they promoted the idea that the high inflation of the 70s was a monetary phenomenon and wasn't caused by the eclectic array of factors which at the time was the consensus view.

And the shadows minority vision, along with monetarism and Milton Friedman eventually won the debate. And as monetary policy issues have evolved over the past half century, the Shadow and research by its members have continued to influence central bank policy-making in the US and abroad. And the Shadow has always emphasized sound money and the importance of a nominal anchor in the conduct of monetary policy.

It has highlighted the benefits of a rules based monetary policy rather than a discretionary approach. It's highlighted the benefits of heightened central bank transparency on fiscal policy. The SOMC has urged fiscal restraint and the importance of the Fed to steer clear of fiscal policy, credit policy and its involvement through the balance sheet.

And these stances align closely with the beliefs and research of scholars here at the Hoover institutions. There's a complementarity between us and the range of the Shadow's expertise has broadened as the Fed and global central banks have expanded their roles. And adding to the shadows legacy of monetary policy scholarship.

Shadow members include experts on in banking, bank regulation, financial stability, the Fed's expanded balance sheet, its role in international finance, monetary history, that's me and government issues. And historically, several members of the Shadow have joined the Fed. And now the current Shadow includes several former FOMC Federal Reserve members.

The current issues facing monetary policymakers are critically important to healthy economic performance as they were in the past. The Shadow has played an important role as a watchdog on the Fed's policies in the past and promises to do so in the future. We thank the Hoover Institution and especially John Taylor and Marie Christine Slakey for hosting and arranging this special conference.

We also thank the Bradley Foundation and Smith Richardson Foundation for generous support to highlight the evolution of monetary policy in the Shadow. In the last 50 years, and to address the key issues facing today's policymakers. The conference includes participation by SOMC members, by leading scholars of the Hoover Institution, and current and former members of the Federal Reserve, and also foreign central bankers.

Now, John Taylor's famous rule, which is an essential chapter in every central banker's guidebook. And his pioneering research on monetary policy rules have been at the heart of the SOMC's core beliefs for the past three decades. And so now we have the privilege of having John Taylor tell us about rules versus discretion over the past 50 years.

So I'll turn the podium over to John and his slides, thank you.

>> John Taylor: I'd say it's impressive to see all of you, especially this table in front of me. Amazing experience for me. So I'm gonna talk about this title, rules versus discretion over the last 50 years. Where did he get 50 years?

Well, that's how long the Shadow has been operating, and it's 1973, is what I found out. It's prepared for this conference, which we have a title, a 50 year retrospective on the Shadow Open Market Committee, and it's role in monetary policy. And we're here in the tritel building.

So thank you, David and Joan at the Stanford University place. So let me first mention a few people who are behind the SOMC. Alan Meltzer, of course, an old colleague. Where's Marilyn? Marilyn, thank you for being here, thank you.

>> John Taylor: Alan and I are long-term colleagues. I grew up in Pittsburgh.

I admired Carnegie-Mellon for so long. It's a great place, thank you. And Carl Bruner was another member of the original group of three or four or five, however many you actually want to mention. And of course, Anna Schwartz is a very important part of the operation. I have to say, for me, maybe coming from Stanford, where Milton Friedman had his office a few doors down from mine.

I'm thinking of Milton, too, is part of the theory, part of the idea, part of what's going on in this whole thing. So the policy statement, which really goes back to Milton and emphasized a lot of monetary aggregates, that's for sure, more than I'm used to doing. So I'm going to do a little bit of that.

And let me say, if I might at the start, that I want to talk about policy rules. Maybe too much, maybe too much. I think it's very important that we don't forget about policy rules. We forget about them easily if we're not careful. So if you look at the second slide I have is table one from a paper I've recently written called the federal the monetary policy rules as reported in the Fed's report.

And you can see the Taylor Rule, 1993, that's 25 years or so ago. And it's got the interest rate, long term, short term, has the inflation rate pie and it has the unemployment rate LR, and of course, there's various versions of this, if you see. So the Fed has been reporting on this in various ways.

Some of you are responsible, perhaps not. But it's really for me a way to communicate, to have a discussion of what really is going on with Montezdae. Policy, and I can't say enough that I appreciate the opportunity to speak about this topic, given that the FOMC has talked so much about it.

Let me just, if you probably are bored by all the notation, which is part of the deal with Taylor rule, first is just the Taylor rule is the most important. But if you go to the second chart, I'll tell you more about it. This is going back 50 years.

This is a celebration, we're having 50 years. It's the federal funds rate, effective rate. And you can see the percent is on the vertical axis, years are on the horizontal axis, and it's called the effective federal funds rate. It goes back to the late 60s and 70s, 80s, 90s, 2000, 2010, and there it is at the end.

And so we've been seeing this for a long time. And this is the data, this is what the Fed reports. And you can see it got up to almost 20%, those are the bad old days. And what was going on when we were doing that, let's not go back to that, whatever we do.

But since then, and to some extent, it's because the Fed has followed a more rules-based system. I think that's part of the reason it's gotten lower. And you can see it's gotten a little high recently off to the right. It's a little bit of a dip down, but it's still very high.

And the ideal is 2% if you look in the measure I showed you a few minutes ago. So while it's been very high, it's something that we should try to avoid. I'd like to see it like 2%, 2 and a half percent, 4% in that range. And we don't know if it'll be in that range.

It's not just the Fed, it's other countries as well. So don't forget this chart, this goes back 50 years. And you can see we've had interest rates very high, very low, very, very low, very, very high. And we're sort of a medium stage at this point, trying to get them down a little bit, and we'll see if we're successful at doing that.

But that's really, in a sense, the goal. I think, of the goal is to get the interest rate down to this rate. Now, how do we do that? Well, we have a rule, we have a series of rules, and one of the rules is listed here. So I've got the rule circled in red, it's called figure two.

It's a so-called Taylor rule. A simple version of the Taylor rule is if inflation is 2, p=2, and the GDP gap is 0, y=0, then interest rate is 4. So maybe it's a little bit high now, but basically, it's where it should be. And that's coming, it doesn't really matter which version you use to say the same thing, but this is the so-called Taylor rule.

And you can dispute this, argue about it as much as you want, but this is the thing that's attracted a lot of attention. And I'll say it's been very gratifying to me. It's attracted attention, but it's not the only reason. Other central banks have followed similar kinds of things as well, and so maybe we can talk about that.

Mike said there might be some questions. I don't know if there are questions, but this is the first one. Just remember, the inflation rate is 2, p=2, and the gap is 0, y=0, the interest rate is 4. So where is it now? 4, now, let me just go to the next chart, which is more up to date.

And it's indicating the interest rate decisions that the Fed has made, as it says. Figure 3, the Fed held the interest rate lower than the so-called Taylor rule, and the inflation rates rose sharply as the Fed then tightened policy. I know it's hard to see, but the graph started to rise in 2016, and then it fell down in 2019, 2000, and then it started to increase again.

So what I say is the mistake, if you like, was going down all the way to nearly 0 and then reversing very quickly coming back up again. And so this is the kind of thing you wanna try to avoid. You wanna signal as much as possible what you're doing.

If the Fed really wanted to signal that in advance, it could have, but it didn't. We don't know exactly why it didn't. Maybe I'll look at some of the people who decided that. But that's the idea. And so the idea is as we have already talked about, start to come down again, and we get to this 4% level.

Now, the next chart is a little bit of history, goes back to January 2019. It's called figure 4. This chart shows that the policy was too low. You can see it's too low, and this was the reason the inflation rose. And so you can just study this a few minutes.

The policy rate is the dark blue line. The dashed line is the recommended policy based on the generous Taylor rule. And the recommended policy is a less generous policy rule is the one that you can hardly, it looks like a straight line. And you can see they're very low by any measure.

And so that is the notion that I've focused on a lot in my discussion. I said, be careful what you're doing if you're not exactly right on, and so that's the danger that you run into. We can debate this, the ideal would be to keep the rate as close as possible to the ideal rate at this point.

And this is an example of that. You can see how far they were off at the time. Now, finally, if you look at figure 5, and I'll try to wrap up as much as possible. This is figure 5. This is the actual implicit price deflator. So this is the best measure we have of the inflation rate.

And you can see how it got very high in the 50s, and 70s, and 80s and came down to quite low, except for this recent period where it jumped to nearly 10%. And that's the domestic price deflator. That's really what the Fed focuses on and looks on, at least one of the things they look at and talk about a lot.

And so now it's starting to come down, question's, will it stay down? Will it stay at this 2% target, which is the Fed has been very explicit about 2% about where they're trying to go? It's closer to 2 and a half, 2 and a half, 3. And so really that's the ideal.

And you could see, you wanna avoid these spikes. The spikes are not the ideal situation that you have. If you go to figure 6, this is the unemployment rate as well. Yes, the unemployment rate. So the unemployment rate rose well above the target range up to 15%. It's come down quite a bit, so we don't think about that so much anymore.

But you can see the rate really rose, this is from 2008 to the present. And you can see the unemployment rate rose quite a bit, and that's because of the Fed putting on the brakes and trying to do something about this high inflation rate, which they are trying to avoid.

So this is the Fed completely. Now, one thing that's very important to keep in mind, and I'll spend a few minutes on this, is the Fed is only part of the global monetary system. There are other countries involved as well. There's ECB. There's the Bank of Japan. There's China.

They're all over the place. And so the last chart I want you to focus on is the inflation rate in Latin America, our neighbor, it goes to January 22, and includes Brazil, Colombia, Chile, Mexico and Peru altogether. And then the LA five. And you can see it has increased really at the same time as the Fed.

And so this is, the Fed is not unique in this respect. The Fed has really led the way, perhaps its and a factor in all these countries. Now these countries will come down, we hope, to 4% or 2% or wherever they want to be. And the idea is to find a global monetary system, and that's the goal, which is similar to what the Fed.

So the idea here, and just conclude with this, the idea is, as we try to reform our international monetary system, let's try to find a way that we have other countries, Russia, China, Japan, be part of the same system, not exactly the same, but as part of the same system.

And they can do that by having a rule or a strategy which is similar, maybe not exactly the same, but similar to the Fed. That means there's more discussion internationally. I spent a lot of time when I was in government, working internationally, trying to figure out ways to have other countries be involved in this decision.

But I think ultimately what we want to have is a situation where not just the Fed, not just the Europe, not just China, not just Japan, but we have countries that are at the same method, same mechanism, and don't have this situation occurring again. So we're not there yet.

And let me just conclude that we're not there yet. We're close, if you like. We're closer than we were two or three years ago. We were very far away. We seem a little closer than we were. But we need to focus on this as a way to remedy the situation.

And I think ideally, we'd like to have. This is the Fed's, so called Fed's targets, 2% for inflation and the same 2% for globally, and have other countries be involved in that, too. So I'll stop there, thank you.

>> Michael Bordo: We can take a couple of questions and answers.

Questions and then answers. Okay, Bill Nelson.

>> Bill Nelson: Thank you, John. Bill Nelson from the bank policy Institute. So, to prepare for this event, I went back and read some of the original transcripts and research prepared for the very first. So I find it hard to say SOMC. SOMC meetings.

And I was really struck by the distinction that they expressed for caring about interest rates when thinking about monetary policy and the focus that they put on balance sheet items, including money. And so I was just curious. But of course, your rule is all about interest rates, interest rates that presumably are implemented through fine tuning operations very much sort of antithetical to some of the things that they held dear.

So I was hoping you could sort of pull those two things together and explain the intellectual connection between your work on rules based asset policy and their original views about what was important and what wasn't important.

>> John Taylor: So I've been interested in monetary policy rules all my life, starting before there was interest rate rules, where there were just money growth rules.

So I have some experience with that. And see, my experiences drew me away from that, not completely, but if we go back to that, it's fine, but it's so far driven me away from it. And I think in some sense, it's easier to think about what the interest rate should be.

Also, think about multi, this is a global situation. Think about Europe, think about China, think about Japan. If we have a way that 2%, 3%, 4% is the rate that's discussed as the second part of your question more globally, then we'll be in better shape. I think that's the way to think about it.

Is there a way that we can have the global system more attuned to a 2% target globally? Maybe 2% is too high, maybe it's too low, but it seems to be a rate which many people have agreed to have thought about. And so let's stick with 2% and try to find a way that other countries can be part of that.

>> Kevin Chen: Yeah Kevin Chen, that's horizon financial question. You mentioned about Japan, right? So Japan has been in zero interest rate for so long, they tried to increase the rate, caused such a big turmoil this year. Do you think, Taylor roll to apply to Japan? What's the pros and cons?

Let's say if we do increase to 3%, let's say.

>> John Taylor: Well, the Japanese, the Bank of Japan, I know most of them pretty well. Look at the tail of rule they talk about the tail of rule don't mean they follow it. They were too low that space. They were too low for a while, now they seem to be catching up.

And so that's a good sign. That's a good way it should be unfolding. It seems to me whether they'll go all the way or not, I don't know. It's not finished at this point. And they have big trading partners nearby, China in particular, and Russia nearby, which have to think about.

But I think the notion, bear with me, the notion that the Fed leads the way or is a leader in this method makes quite a bit of difference. So I think that's why I would argue that the Fed is a key player in this debate.

>> Speaker 6: Yes, in 2012, through the pandemic recession, m2 and nominal GDP were up 2 to 3%.

Then the federal reserve increased the money supply by 35% according to monetarist doctrine. A year later, inflation took off. Powell has said that he doesn't pay attention to money anymore. Is this a mistake on Powell's part? And do you think that money was the major cause of the inflation?

>> John Taylor: I don't think it was the major cause. I showed you charts which indicate that the rate was too low, the interest rate was too low. I'm not saying that money is not important. Money is very important. And I worked on money more than half of my life.

And so I think it's an important aspect, but it's not the only aspect. And I think to some extent, internationally, it's easier to think about other countries with having this same kind of interest rate as the US, maybe not exactly the same, different circumstances in other countries that will be better off.

And so that's the ideal I have is you have a system whereby not just the United States, but this is a global situation, other countries do the same kind of thing. So that's my short answer to your very difficult question.

>> Speaker 7: Thank you. I'm wondering, particularly in the last chart, there were actually several central banks that raised rates before the Fed, particularly in emerging markets like Brazil and Czechia.

And yet they seem to have had similar, if not worse, inflation outcomes in the United States. I'm just wondering if you could kind of walk through why you think that might have happened. Thank you.

>> John Taylor: So different central banks are different. There's different mechanisms, different ways, prices and wages are set.

So that's probably the reason why you're seeing not exactly the same, it looks like. Exactly. In fact, if you look around the world, some are in good shape, some are in bad shape. And so I think that's why monetary policy is so difficult. You have to have some sense of what's going on individually in each country.

And that's what I would argue for is looking at these Latin American countries as well. It's not just Latin America, it's just to give an example where the rate is increased substantially, the inflation rate has increased substantially during this period of time, and it gives you a sense of what to look for.

That's it. Okay.

>> Michael Bordo: Thank you.